Investing in Oil with ETFs


 
 
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by S. Wade Hansen

Oil is at Support and Demand is Near a Bottom

After soaring to absurdly high levels just below $150 per barrel, the price of oil lost approximately 75 percent of its value and bottomed out at $35 per barrel.Now is the Time to Buy Oil ETFs

At the time, I didn't think the price of oil was going to drop below $35 per barrel for the following reasons:

- $35 per barrel was resistance for years and years. Once oil broke up above $35 per barrel in 2004, the $35 price level became a strong support level.

- As the economy begins to rebound, demand for oil is going to increase—especially in China.

- The future value of the U.S. dollar (USD) is going to be damaged by all of the money the U.S. government is pumping into the markets. As the USD goes down, the price of Oil will go up.

We have now seen the price of oil break up and through resistance at $50 per barrel, and it will most likely stay near this level and continue moving higher as we head into the summer driving months in the United States.
 
   
 
Taking Advantage of the Boom with ETFs

One of the easiest ways you can take advantage of the coming rise in oil prices is through exchange-traded funds (ETFs). Oil-based ETFs increase in value when the price of oil goes up. If you're a little rusty on your ETFs, check out Understanding Exchange Traded Funds (ETFs).

Here are a few ETFs you should look at if you believe the price of oil is going to go up:

- iPath S&P GSCI Crude Oil Total Return ETF (NYSE: OIL)

- United States Oil Fund LP (NYSE: USO)

Don't Agree? Think Oil is Going to Drop?

Of course, you may not agree with me. You may believe the price of oil is going to drop even farther. If so, you can still take advantage of oil prices using "short" ETFs.

"Short" ETFs are investments that increase in value when the price of the asset covered by the investment goes down. In other words, short oil ETFs make money when the price of oil goes down.

Here are a few short ETFs you should look at if you believe the price of oil is going to go down:

- MACROshares $100 Oil Dwn Trust (NYSE: DOY)

- ProShares UltraShort DJ-AIG Crude Oil ETF (NYSE: SCO)
Comments Add New
adnan  - tuadi maa di phudi   |2009-01-20 15:23:38
what will be the prices of uscrudeoil within 1,2 months,
swadehansen  - No One Knows   |2009-01-20 16:15:20
Predicting what the price of oil is going to be in 1 to 2 months is
impossible.

Here's what I'm trying to point out. The price of oil is in a
nice consolidation range, and by buying now, you have a great risk/reward
potential. If oil drops below $35 per barrel, you could get out with minimal
losses. If you hold on, and prices rise, it will most likely be a nice,
prolonged move upward.
Mark Larsen  - Leading Indicators   |2009-01-20 16:24:48
Aren't there any leading indicators to predict prices?
swadehansen  - Leading Indicators   |2009-01-20 16:38:53
Certainly, there are fundamental factors and price patterns and other technical
indicators (like the ones I listed above) that can help you determine if the
odds are in your favor, but none of them is infallible. There is always risk,
and nobody can tell you for certain where the price is going to be.
Boustany  - Rollover days   |2009-01-20 18:03:06
Hi Wade,
Please can you give more details about roll over days?
yesterday
february contract expired at about 33-34 and today march contracts entered there
spot month at 40 so we have a gap 6 tp 7 dollars. so if someone wanted to roll
over he would automaticaly loose this spread.
and how does ETFs account for
this spread?

thanks

Teddy
swadehansen  - Contango   |2009-01-21 00:01:02
Here's a great post I found on "Oil Traders Blog" that explains things
pretty well [ http://oiltradersblog.blogspot.com/2008/12/contang
o-scares-uso-and-dbo-investors.html ]

Contango is the deepening discount of
near month oil futures contracts against later months. This little monster is
scaring investors off simple passive funds such as USO, DBO and OIL that helped
drive the big oil rally in the last 6 years.

Passive index plays like USO and
OIL found big profits during much of oil's rally to over 147 a barrel in July by
selling front month futures contracts and buying cheaper ahead the curve
contracts, something possible only in a market structure called
backwardation.

Oil prices have collapsed to 35 dollars a barrel pushing front
month futures contracts into a discount to later months. This is a market
showing contango, which forces investors to pay out rather than profit when
shifting cash from one mon...
Ivani  - USO and Oil contango   |2009-01-21 02:57:42
Hi Wade,
I want to ask how will react USO price. There is big contago in oil
prices. I am not very sure, that USO must go up. Is USO ETF holding some
Futures (and rolling with loss)or having Physical Crude Oil?

thx Ivani
swadehansen  - USO Holdings   |2009-01-21 07:05:03
Here's a summary of the holdings in the USO ETF:

The Company invests in
futures contracts for light, sweet crude oil and other types of crude oil,
heating oil, gasoline, natural gas and other petroleum-based fuels that are
traded on the New York Mercantile Exchange (NYMEX), International Currency
Exchange (ICE) Futures or other United States and foreign exchanges
(collectively, Oil Futures Contracts). It holds interests in other oil-related
investments such as cash-settled options on Oil Futures Contracts, forward oil
contracts, and oil-based over-the-counter transactions.
Pascal  - consolidation level   |2009-01-23 12:06:46
In your demonstration, you say that it is typical of commodities to bounce down
against a certain level for years, then break it, then bounce up from that
level. Can you provide an specific example for which the price curve clearly
show this mechanism over the last decades?
Thanks
Brett  - brocky   |2009-02-26 10:24:24
Hi Wade, I really appreciate your info. As a new investor to Oil and ETF's i
have at the moment a long term bullish view on oil and want to know about the
best ETF. I know you listed USO however further reading on your explanation on
Contango is the Oil ETF USL a better investment play on long term oil or would
you be happy still with USO as a long term play. Need some guidance....USO or
USL for long term Oil play like your chart explanation is saying...???
Gareth  - USO or USL Long Term Oil Play ?   |2009-02-26 10:34:55
Is the volume on USL if you recommend it ok for long term? It seems USL is less
exposed to Contango than USO as its 12 month contracts. If you have a future
view of Oil between $100-200 which ETF do you recommend to invest in now?
swadehansen  - Contango and the USO vs. USL   |2009-02-27 01:48:44
Great questions/observations, you two. You nailed it on the head. If crude oil
futures contracts are in contango, the USL (which spreads its capital over
futures contracts that span the next 12 months) has a definite advantage over
the USO (which puts all of its capital in the front month) because it rolls its
positions over at a much slower rate.

Of course, the USO will have an
advantage when crude oil futures contracts are in normal backwardation because
the frequent rollovers will put money in investors pockets instead of taking it
out like it does when the market is in contango.
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